Raising Finance

In order for firms to expand and invest they require the adequate capital to do so. Firms could raise the money internally through retained earnings. Take Apple Inc. for example in their 2011 10-K annual report released on October 26th 2011 they were found to have $81.57 billion in cash available. Therefore, if Apple Inc. wanted to invest in a new project getting cash would not be much of an issue. Most firms however, are not in the fortunate position Apple Inc. find themselves in.

However, Apple Inc. has not always had billions in the bank. The way many companies start up is through raising money externally. This will initially be through debt finance such as loans from the bank. As the company expands more opportunities of accessing finance become apparent. One is equity finance; which mainly involves the issue of ordinary shares. Different forms of debt finance also become available such as being able to issue bonds.

Equity finance, what is it all about?  Well as already mentioned it is the issue of ordinary shares. However, you don’t necessarily have to be listed on a stock market to sell shares in your company. It could be as simple as selling a stake in the company in return for a lump sum investment from family and friends. However, family and friends may not have adequate capital available to fund the ambitions of the company. This is where professional investors come in to the mix. We call these venture capitalists.  These investors are primarily concerned with getting a high return from their investment due to the risk involved. Although there may be risk involved for the venture capitalist it is great way for up and coming businesses to raise finance. If you want a prime example of a venture capitalist then tune into the TV programme Dragons Den.

The other way to raise equity finance is by listing on a stock exchange and issuing ordinary shares. This is an easy way to raise finance for a company. The capital does not even have to be repaid and there is no obligation to pay dividends. The only problem with raising finance this way is that companies lose control, as shareholders in return for their investment are allowed a say in company matters. Listing on stock exchanges can also be expensive and the market values of companies’ shares also have to exceed a certain amount. In May 2011 Glencore became the largest public offering in the London stock exchange’s history.  Its reason for exposing itself to public scrutiny was so it had the financial firepower to participate in the natural resources industry. This is the main advantage of listing on stock exchanges it provides you with more power!

Do you really want to lose control of your business? If not then there is always debt finance. This could simply be obtained as a loan from a bank. Unfortunately in the current economic climate the issue of bank loans for businesses are extremely hard to come by. The government has tried to improve lending to businesses through Project Merlin. The BBC outlines that under Project Merlin, Barclays, HSBC, Lloyds Banking Group, RBS and Santander UK, were to make it easier for smaller firms in particular to access credit. However, recent Bank of England figures show that under project merlin the five banks are failing in some of their lending targets. 

Let’s get a bit more complicated in terms of debt finance and talk about bonds. We see them talked about all over the news, particularly Greek bonds, but what are they? Simply put by the oxford dictionary of finance and banking; a bond is an IOU issued by a borrower to a lender. They are issued by governments and companies as a means of raising capital. The holder of the bond is the creditor and the issuer the debtor. The bond guarantees its holder both repayments at a later date and a fixed rate of interest.

Bonds are seen to be pretty safe for the creditors; they are also a good way for firms to raise finance. The risk of bonds tends to fall on the creditors, if inflation or interest rates go up, but there is little risk on the debtor side. Bonds can be quite an attractive prospect for creditors as returns can be substantial. The European Central Bank for example paid about €40bn for Greek bonds which currently have a face value of €55bn. Investors who bought Irish bonds when the country was struggling amidst the credit crunch can expect a 50% return on their investment.

Of course firms don’t have to choose between equity and debt finance, they can use a mixture of the two. The weighted average cost of capital (WACC) another complex term is used to work out the average costs of these types of financing. By taking a weighted average, we can see how much interest the company has to pay for every unit of cash it finances. The WACC is used by investors to assess whether they will get a good return on the money they invest in.

There are problems with raising money through equity and finance. However, I personally would not like to have my business funded primarily through debt. This is what caused the problems which led to the credit crunch and is why banks are sketchy when it comes to lending. It is the reason why we are suffering a crisis in the Eurozone. On the other side of the coin companies need to take on debt in order to raise the required capital to expand. What we have is a catch 22 situation. Debt is seen as bad but it needs to be taken on to achieve good.

Sources Used: /http://investor.apple.com/, Business Link, Investopedia, BBC, FT, FT lexicon, Reuters, Oxford dictionary of finance and banking (2008).